10 comments:

I would have thought that trying to control inflation with high interest rates (and no taxes)whilst letting deficit spending go wild (what Mitchell seems to advocate) would actually create runaway inflation.

Deficit spending is not inflationary so long as interest rates remain low enough.

If interest rates are too high for a given deficit/debt, the interest payments on either govt debt or reserves (assuming IOR) will get completely out of control.

Although I think you would have to do some wild deficit spending before you ran out of people to produce the goods and services that people would want to purchase with that extra income. Especially since we are in a world market for a lot of stuff. The world prosperity we would go through on our way to running out of earthlings to employ would be fantastic though....

Raising interest rates works two ways. First it raises the cost of capital, of which woking capital to make payroll is of immediate concern to firms, since it raises the cost of payroll without actually raising wages. Business try to pass that one with higher prices until price resistance is met, then they compress margins to remain competitive. Finally, they throw in the towel in aggregate and begin to layoff workers to cut back on the build up of unplanned inventory. That's the immediate channel of raising rates.

The longer term and more powerful channel is through the housing channel since mortgage rates rise with the interest rate and this depresses investment in housing, which is one the most important contributors to the economy. This is the secondary channel that kicks in after the first.

Of course, there are other factors but these are the big ones that move the economy through rate changes.

ok, by "wild" I meant "functional" in the MMT sense rather than "sound" in the mainstream sense.

Tom,

Let's say the govt deficit spends by issuing money directly rather than by issuing bonds (borrowing).

Over time reserves pile up, and unless interest is paid on reserves the base interest rate will fall to zero, I guess.

So, let's say the govt decides to pay 10% interest on those reserves for some reason (let's say R M Mitchell is running the govt).

Those reserves will soon be increasing exponentially (due to the compounding interest payments), unless the govt either drastically cuts back on spending or raises taxes high enough to drain enough reserves out of the system.

Despite the fact that the higher interest rates may discourage lending, money is still pouring out of the government into private accounts through interest payments. At some point the govt has to stop the deluge by either reducing rates (at which point the flood gates truly would open through spending into the wider economy), or they have to tax a huge amount of it back.

The larger the deficit/debt, the lower the interest rate has to be for it to be "sustainable" in terms of its long term inflationary impact.

y, the way I understand it is that monetarism has the role of interest rates wrong in the view of MMT, which sees fiscal policy as the effective way to address what monetary policy is supposed to but does inefficiently (results in idle resources) and effectively (acts indirectly), whereas fiscal fiscal policy is efficient (no idle resources) and effective (targeted directly).

The question then becomes what to do about interest rates. According to MMT, the interest rate influences investment as the cost of capital. The Fed should therefore set the rate to zero and let the market determine interest rates for borrowing, since borrowing is chiefly for investment.

Investment involves risk, and the market is best able to evaluate risk (after the adoption of the reforms that MMT recommends). Setting the rate to zero would set the stage for low cost of capital, facilitating investment, and then it would be up to the market to allocate funds accordingly.